Intercompany Transfers of Services and Noncurrent Assets

Chapter 7
Intercompany Transfers
of Services and
Noncurrent Assets
Copyright ©2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Learning Objective 7-1
Understand and explain

concepts associated with
transfers of services and
long-term assets.
Copyright ©2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 7-2
Summary of GAAP Requirements for
Preparing Consolidated Statements
 All intercompany transactions must be

eliminated in consolidation.
 The full amount of unrealized intercompany
profit or gain must be eliminated.
 The deferral is shared with NCI shareholders in
upstream transactions.
Big Picture: The Consolidated Perspective
 From a consolidated viewpoint,

the reported amount for a fixed
asset cannot change merely
because the asset has been
moved to a different location
within the consolidated group.
P
Long-term
 Objective: Asset
 Undo the transfer.

 Make it appear as if we only S
changed the estimated useful
life of asset.
Different Asset Types
 Nondepreciable Assets
 The transfer of nondepreciable assets is very similar to the
transfer of inventory.
 Eliminate gains like unrealized gross profit.
 Depreciable Assets
 Eliminate the seller’s gain.
 Adjust transferred asset back to old basis
 Adjust depreciation back to what it would have otherwise
been if the original owner had depreciated the asset based
on the revised estimate of useful life.
Intercompany Transfers of Services
 When one company purchases services from a

related company, the purchaser typically records
an expense and the seller records a revenue.
 In the consolidation worksheet, a consolidation
entry would be needed to reduce both revenue
(debit) and expense (credit).
 Because the revenue and expense are equal and
both are eliminated, income is unaffected by the
consolidation.
 The consolidation is still important because
otherwise both revenues and expenses are
overstated.
Intercompany Long-Term Asset Transfers
 The sale of an asset wholly within the consolidated entity

involves only a change in the technical owner of the asset.
 Does not represent the culmination of the earning process.
 To culminate the earning process with respect to the
consolidated entity, it must make a sale to a party external to
the consolidated entity.
 Key to deciding when to report a transaction in the
consolidated financial statements: visualize the consolidated
entity and determine whether a particular transaction
 Occurs totally within the consolidated entity (in which case its
effects must be excluded from the consolidated statements) or
 Involves outsiders (and thus constitutes a transaction of the
consolidated entity)
Practice Quiz Question #1
The goal in preparing eliminating entries

related to asset transfers among affiliated
companies is to
a. emphasize gains and losses in the
consolidated financial statements.
b. eliminate gains and losses and readjust
the basis of the transferred asset to what
it would have been on the original
owner’s books.
c. augment consolidated income.
d. decrease consolidated income.
Practice Quiz Question #1 Solution
The goal in preparing eliminating entries

related to asset transfers among affiliated
companies is to
a. emphasize gains and losses in the
consolidated financial statements.
b. eliminate gains and losses and readjust
the basis of the transferred asset to what
it would have been on the original
owner’s books.
c. augment consolidated income.
d. decrease consolidated income.
Prepare simple equity-

method journal entries
related to an intercompany
land transfer.
Intercompany Land Transfers
 When intercompany transfers of noncurrent

assets occur, the parent company must make
adjustments in preparation of consolidated
financial statements for as long as the
acquiring company holds the assets.
 When related companies transfer land at book
value, no special adjustments are needed in
preparing the consolidated financial
statements.
Overview of the Profit Consolidation Process
(1 of 5)
Company A purchases land for $10,000 and sells

it to its subsidiary for $10,000:
Parent Subsidiary
Cash 10,000 Land 10,000
Land 10,000 Cash 10,000
 The asset continues to be valued at the $10,000

original cost to the consolidated entity.
 Because the seller records no gain or loss, both assets
are stated correctly from a consolidated viewpoint.
(2 of 5)
Peerless Products Corporation acquires land for

$20,000 on January 1, 20X1:
January 1, 20X1
Land 20,000
Cash 20,000
Record land purchase.
Overview of the Profit Consolidation
Process (3 of 5)
Peerless sells the land to its subsidiary, Special

Foods Incorporated, on July 1, 20X1, for $35,000:
Parent Subsidiary
Cash 35,000 Land 35,000
Land 20,000 Cash 35,000
Gain on Sale of Land 15,000
Record sale of land to Special Foods. Record purchase of land from Peerless.
 The intercompany transfer leads to a $15,000 gain on

Peerless’ books and the carrying value of the land
increases by the same amount on Special Foods’ books.
 Neither of these amounts may be reported on the
consolidated financial statements because the $15,000
intercompany gain is unrealized.
Overview of the Profit Consolidation
Process (4 of 5)
 When intercompany gains or losses on asset transfers
occur, the parent company can choose to use the fully
adjusted equity method, which requires it to adjust
its investment and income from subsidiary accounts
to remove the unrealized gain.
 The following equity-method entry would be made:
July 1, 20X1
Income from Special Foods 15,000
Investment in Special Foods Stock 15,000
Defer gain on intercompany land sale to Special Foods.
(5 of 5)
 In the consolidation process, the gain should be

eliminated and the land restated from the $35,000
recorded on Special Foods’ books to its original cost of
$20,000.
 This is accomplished with the following consolidation
entry in the consolidation worksheet prepared at the
end of 20X1:

Land 15,000
Example 1: 100 Percent Ownership Land
Transfer (Nondepreciable) (1 of 3)
 On 3/31/X5, Parker Inc. sold land costing $40,000 to its 100
percent–owned subsidiary, Stubben Inc., for $100,000.
 In this example, we’ll do consolidation worksheet entries
without adjusting the equity method accounts.
 This is the modified equity method.
 This is meant to be a conceptual exercise only. (We will
switch to the fully adjusted equity method next.)
Required:
1. Prepare the consolidation entry(ies) as of 12/31/X5 and
12/31/X6.
2. Prepare the consolidation entry at 12/31/X7, assuming that
Stubben sold the land in 20X7 for $120,000.
On 3/31/X5, Parker Inc. sold land costing $40,000 to its
100 percent–owned subsidiary, Stubben Inc., for
$100,000.
In 20X7
$40 Parker $100 Stubben $120
“Fake” Gain = $60 Gain = $20
Total Gain = $80

Example 1 Hint: Developing Fixed Asset
Elimination Entries
 Compare “Actual” with “As if ”

 “Actual” = How the transferred asset and
related accounts actually appear on the
companies’ books.
 “ As if ” = How the transferred asset and
related accounts would have appeared if the
asset had stayed on the original owner’s
books.
 The difference between the two gives

the elimination entry or entries.

$100,000.
Gain on
Land Sale of Land
100,000 “Actual” 60,000
60,000 60,000
40,000 “As if” 0
Gain on the Sale of Land 60,000

Land 60,000
Example 1: Consolidation Entry at 12/31/X5
Requirement 1:
Parker Stubben
Assets = Liabilities + Equity Assets = Liabilities + Equity
Gain +60 Land +60
Consolidation Entry at 12/31/X5

Land 60,000
What happens to the gain?
RE +60 Land +60

Requirement 1:
Parker Stubben
RE +60 Land +60
Consolidation Entry at 12/31/X6 (and all years until land is sold)

Retained Earnings 60,000
Land 60,000
Requirement 2:
Parker Stubben
RE +60 Gain +20
What gain should Stubben report in 20X7 when the land is sold?
Consolidation Entry at 12/31/X7 (Stubben resold the land in 20X7)
Gain on Sale 60,000
• Thus, the gain in the consolidated financial statements is $80,000!

• What’s the only problem with the modified equity method?
• THE PARENT’S FINANCIAL STATEMENTS ARE NOT CORRECT!
Example 1 Solution: Parker Company
Equity-Method Journal Entries
Requirement 1
Land 60,000
Land 60,000
Requirement 2
Example 1: Equity Method Adjustment
 After calculating the unrealized gain, simply make an

extra adjustment to back it out.
 Do this at the same time you record the parent’s share of
the sub’s income.
Investment in Sub Income from Sub

NI XXX XXX NI
60,000 Unreal. Gain 60,000
This ensures that
the parent income
Reverse later when the is equal to the
asset is sold! consolidated
income.
Example 2: 100 Percent Ownership
Land Transfer (1 of 2)
 On 3/31/X5, Parker Inc. sold land costing $40,000 to its 100
percent–owned subsidiary, Stubben Inc., for $100,000.
 Now assume Parker adjusts for this transaction in the equity
accounts.
 This is the fully adjusted equity method!
 How would your answers change?
Required:
1. Prepare the consolidation entry(ies) as of 12/31/X5 and
12/31/X6.
2. Prepare the consolidation entry at 12/31/X7, assuming that
Stubben sold the land in 20X7 for $120,000.
Land Transfer (2 of 2)

100percent–owned subsidiary, Stubben Inc., for
$100,000.
In 20X7
$40 Parker $100 Stubben $120
“Fake” Gain = $60 Gain = $20
Total Gain = $80

Example 2 Hint: Developing Fixed Asset
Elimination Entries

companies’ books.
 “ As if ” = How the transferred asset and
books.

Land Transfer (Nondepreciable)

$100,000.
Gain on
Land Sale of Land
100,000 “Actual” 60,000
60,000 60,000
40,000 “As if” 0

Land 60,000
Example 2: ONE EXTRA STEP! Equity Method
Adjustment
NI XXX XXX NI
60,000 Unreal. 60,000
Gain
This defers the

gain until later
Requirement 1:
Parker Stubben
Invest 60 Gain +60 Land +60
Income from Sub 60
• The equity method adjustment “fixes” parent’s books!
What happens to the equity method accounts?
• Eliminated in the consolidation. But we still need to fix the problem!
Same!
Land 60,000
What happens to the gain AND Income from Sub?
Invest 60 RE correct Land +60 They cancel out!
Requirement 1:
Parker Stubben
Invest 60 Land +60
Investment In Sub Land

Low by 60,000 “Actual” 100,000
60,000 60,000
Normal “As if” 40,000
Balance

Investment 60,000
Land 60,000
Requirement 1:
Parker Stubben
Invest 60 Gain +20
Investment In Sub Gain on Sale

Low by 60,000 “Actual” 20,000
60,000 60,000
Balance
What gain should Stubben report in 20X7 when the land is resold?
Investment 60,000
Gain on Sale 60,000
Example 2: Solution Summary
Requirement 1
Land 60,000
Investment in Stubben 60,000
Land 60,000
Requirement 2
Example 2: Consolidation Worksheet—
20X5
Adjustments
Consol-
Parent Sub DR CR idated
Income Statement
Gain on Sale 60,000 60,000 0
Income from Sub (60,000) 0
Lower Basic
Balance Sheet
Investment in Sub (60,000) 0
Lower Basic
Land 100,000 60,000 40,000
20X6
Adjustments
Consol-
Income Statement
Balance Sheet
Investment in Sub (60,000) 60,000 0
Lower Basic
Land 100,000 60,000 40,000
20X7
Adjustments
Consol-
Income Statement
Gain on Sale 20,000 60,000 80,000
Balance Sheet
Lower Basic
Land 0 0
The major difference between the modified

and fully adjusted equity methods of
accounting for fixed asset transfers is
a. the parent’s income is always lower under
the modified equity method.
b. the parent’s income is always higher under
c. the parent’s income equals consolidated
income under both methods.
d. the parent’s income equals consolidated
income under the fully adjusted method.
The major difference between the modified

and fully adjusted equity methods of
accounting for fixed asset transfers is
a. the parent’s income is always lower under
b. the parent’s income is always higher under
c. the parent’s income equals consolidated
income under both methods.
d. the parent’s income equals consolidated
income under the fully adjusted method.
Prepare equity-method
journal entries and
consolidation entries for the
consolidation of a subsidiary
following a downstream land
transfer.
Downstream Sale of Land (1 of 2)
 In downstream transactions, the sale (and

associated unrealized gain) resides on the
parent company’s income statement.
 Because we assume the NCI shareholders do not
own parent company stock, they do not share in
the deferral of the unrealized gain.
 As a result, the parent company will defer the
entire sale on the intercompany sale of land
because the entire sale belongs to the parent
company and its shareholders.
Downstream Sale of Land (2 of 2)
 Peerless products purchases 80 percent of the

common stock of Special Foods on December
31, 20X0, for its book value of $240,000, and the
fair value of Special Foods’ noncontrolling
interest on that date is equal to its book value of
$60,000.
 Special Foods reports net income of $50,000
and declares dividends of $30,000.
Downstream Sale of Land Fully Adjusted
Equity-Method Entries—20X1 (1 of 4)
Peerless records its share of Special Foods’

income and dividends with the usual fully
adjusted equity-method entries:
Investment in Special Foods 40,000

Record Peerless’s 80% share of Special Foods” 20X1 income.
Cash 24,000
Record Peerless’s 80% share of Special Foods” 20X1 dividend.
An equity-method entry must be made to reduce

Income from Special Foods on the income statement
and Investment in Special Foods on the balance
sheet by Peerless Products’ share of the unrealized
gain ($15,000):

Defer gain on intercompany land sale

Defer gain on intercompany land sale
This entry accomplishes two important objectives:

1. The adjustment to Income from Special Foods
offsets the overstatement so that Peerless’s
bottom-line net income is now correct.
2. The reduction to the Investment account offsets
the fact that Special Foods’ land is overstated by
$15,000.
 Conclusions:
 Peerless’s financial statements are now
correctly stated.
 Peerless’s reported income will be exactly
equal to the controlling interest in net
income on the consolidated financial
statements.
Group Exercise 1: Partial Ownership Land Transfer
 Stubben Corporation is a 90 percent–owned subsidiary of

Parker Corporation, acquired for $270,000 on 1/1/X5.
 Investment cost was equal to book value and fair value.
 Stubben’s net income in 20X5 was $70,000, and Parker’s
income, excluding its income from Stubben, was $90,000.
 Parker’s income includes a $10,000 unrealized gain on
land that cost $40,000 and was sold to Stubben for
$50,000.
NCI
90%
P
 Assume that Stubben sold the land in 20X7 for $65,000. 10%
Assume Parker adjusts for this transaction in the equity
S
accounts.
NOTE: This is a downstream transaction.
Required:
1. What entry(ies) would Parker make in 20X5 and 20X7?
2. Prepare the consolidation entries at 12/31/X5,
12/31/X6, and 12/31/X7.
Group Exercise 1: Solution (1 of 2)
Requirement 1
20X5 Equity-Method Entries

Income from Stubben 10,000
20X7 Equity-Method Entry (after Stubben resold the land)

Group Exercise 1: 90 Percent Consolidation
Entry at 12/31/X5
Parker’s income includes a $10,000 unrealized gain on

land that cost $40,000 and was sold to Stubben for
$50,000.
Gain on
Land Sale of Land
50,000 “Actual” 10,000
10,000 10,000
40,000 “As if” 0

Land 10,000
Entry at 12/31/X6
Investment In Sub Land

Low by 10,000 “Actual” 50,000
10,000 10,000
Balance

Investment 10,000
Land 10,000
Entry at 12/31/X7
Investment In Sub Gain on Sale

Low by 10,000 “Actual” 15,000
10,000 10,000
Balance

Investment 10,000
Gain on Sale 10,000
Group Exercise 1: Solution (2 of 2)
Requirement 2

Land 10,000

Land 10,000

Group Exercise 1: Consolidation
Worksheet—20X5
Adjustments
Consol-
Income Statement
Gain on Sale 10,000 10,000 0
Income from Sub 53,000 53,000 0
Basic
Balance Sheet
Investment in Sub 323,000 323,000 0
Basic
Land 50,000 10,000 40,000
Worksheet—20X6
Adjustments
Consol-
Income Statement
Balance Sheet
Lower Basic
Land 50,000 10,000 40,000
Worksheet—20X7
Adjustments
Consol-
Income Statement
Gain on Sale 15,000 10,000 25,000
Balance Sheet
Lower Basic
Land 0 0
Prepare equity-method
journal entries and
consolidation entries for the
consolidation of a subsidiary
following an upstream land
transfer.
Upstream Sale of Land (1 of 3)
 Assume an upstream sale of land results in the

recording of an intercompany gain on the
subsidiary’s books.
 Unrealized intercompany gains are eliminated
from the consolidation worksheet in the same
manner as in the downstream case.
 However, the gain consolidation reduces both the
controlling and the noncontrolling interests in
proportion to their ownership.
 When an upstream asset sale occurs and the

parent resells the asset to a nonaffiliate during the
same period, all the parent’s equity-method
entries and the consolidation entries in the
consolidation worksheet are identical to those in
the downstream case.
 When the asset is not resold to a nonaffiliate
before the end of the period, worksheet
consolidation entries are different from the
downstream case only by the apportionment of
the unrealized intercompany gain to both the
controlling and noncontrolling interests.
 Peerless Products purchases 80 percent of the

common stock of Special Foods on December
31, 20X0, for its book value of $240,000, and
the fair value of Special Foods’ noncontrolling
interest on that date is equal to its book value of
$60,000.
 Special Foods reports net income of $50,000
and declares dividends of $30,000 during 20X1.
 In addition to the net income of $50,000,
Special Foods also realized a $15,000 gain on
sale of land to Peerless.
Upstream Sale of Land Fully Adjusted Equity-
Method Entries—20X1 (1 of 2)
During 20X1, Peerless records the normal entries under

the fully adjusted equity method, reflecting its share of
Special Foods’ income and dividends:

Record Peerless’s 80% share of Special Foods’ 20X1 income.
Cash 24,000
Record Peerless’s 80% share of Special Foods’ dividend.
These entries are the same as in the illustration of the

downstream sale.
Upstream Sale of Land Fully Adjusted Equity-
Method Entries—20X1 (2 of 2)
 The only difference between upstream and downstream in

the fully adjusted equity-method entry is to defer the
unrealized gain.
 The deferral here is only for Peerless’s ownership
percentage of Special Foods (80 percent).
 Thus, the deferral of Peerless’s relative share of the
unrealized gross profit is $12,000 ($15,000 × 0.80).

Defer Peerless’s 80% share of the unrealized gain on the sale of land to Peerless.
Group Exercise 2: Partial Ownership Land
Transfer
 Stubben Corporation is a 90 percent–owned subsidiary of
Parker Corporation, acquired for $270,000 on 1/1/X5.
 Investment cost was equal to book value and fair value.
 Stubben’s net income in 20X5 was $70,000, and Parker’s
income, excluding its income from Stubben, was $90,000.
 Stubben’s income includes a $10,000 unrealized gain on
NCI
90%
P
land that cost $40,000 and was sold to Parker for $50,000.
 Assume Parker adjusts for this transaction in the equity 10%
accounts.
 Assume that Parker sold the land in 20X7 for $65,000.
 Assume Parker adjusts for this transaction in the equity
accounts.
S
Required:
1. What entry(ies) would Parker make in 20X5 and 20X7?
2. Prepare the consolidation entries at 12/31/X5, 12/31/X6,
and 12/31/X7.
Group Exercise 2: Partially Owned Upstream Sales
Equity Method Adjustment
 Similar to what we did with inventory transfers:

we must share deferral with the NCI shareholders.
 Simply split up the adjustment for unrealized gains
proportionately. NCI
Equity 90%
P
Method
Adjustments 10%
Investment in Income from
S
Stubben Stubben
NI 63,000 63,000 NI
9,000 Unreal. Gain 9,000
54,000
Unreal. 1,000 Gain To NCI Shareholders
Group Exercise 2 Solution: Parker Company
Equity-Method Journal Entries (1 of 2)
Requirement 1
20X5 Equity-Method Entries

Investment in Stubben 9000
20X7 Equity-Method Entry (after Parker resold the land)

Group Exercise 2 Solution: Parker Company
Requirement 2
Land 10,000
NCI in NA of Stubben 1,000
Land 10,000
Requirement 3
NCI in NA of Stubben 1,000
Worksheet—20X5
Adjustments
Consol-
Income Statement
Gain on Sale 10,000 10,000 0
Income from Sub 54,000 54,000 0
Basic
Balance Sheet
Investment in Sub 324,000 324,000 0
Basic
Land 50,000 10,000 40,000
Worksheet—20X6
Adjustments
Consol-
Income Statement
Income from Sub Basic 0

Balance Sheet
Lower Basic
NCI in NA 1,000 1,000
Lower
Land 50,000 10,000 40,000
Worksheet—20X7
Adjustments
Consol-
Income Statement
Gain on Sale 15,000 10,000 25,000
Income from Sub Basic 0
Balance Sheet
Lower Basic
NCI in NA 1,000 1,000
Lower
Land 0
Prepare equity-method journal

entries and consolidation
entries for the consolidation of a
subsidiary following a
downstream depreciable asset
transfer.
Intercompany Transfers of Depreciable Assets
 What is the major difference between depreciable and

nondepreciable assets?
 Depreciation!
 Adds complexity because you have a “moving target” instead of a
stationary target.
 However, the concepts are the same.
 The goal is to get back to the asset’s old basis “as if ” it were still on
the books of the original owner.
 Depreciation must be based on the cost of the asset to the consolidated
entity (which is the asset’s cost to the affiliate company that originally
purchased it from an outsider).
 Consolidation entries are needed to restate:
 The asset
 The associated accumulated depreciation
 The depreciation expense
Developing Fixed Asset Elimination Entries

companies’ books.
 “As if ” = How the transferred asset and
books.
Choosing the Right Depreciable Life
 What’s not relevant?

 The original owner’s remaining useful life at
the transfer date.
 What’s relevant?
 The acquirer’s estimated remaining useful life
(if different from the original remaining life).
Downstream Sale of Depreciable Asset
 Peerless Products sells equipment to Special Foods on
December 31, 20X1, for $7,000. Peerless originally
bought the equipment for $9,000 on December 31,
20W8, three years before the sale to Special Foods. The
equipment was depreciated based on an estimated
useful life of 10 years using the straight-line method
with no residual value.
 The book value of the equipment immediately before the

sale by Peerless is computed as follows:
Original cost to Peerless $9,000
Accumulated depreciation on December 31, 20X1:
Annual depreciation ($9,000 ÷ 10 years) 900
Number of years ×3
(2,700)
Book value on December 31, 20X1 $6,300
Downstream Sale Separate-Company
Entries—20X1 (1 of 6)
Special Foods records the purchase of the

equipment at its cost:
December 31, 20X1

Equipment 7,000
Cash 7,000
Record purchase of equipment.
Special Foods does not depreciate the equipment during
20X1 because it purchased the equipment at the very
end of 20X1.
Peerless does record depreciation expense on the

equipment for 20X1 because it holds the asset until the
end of the year:
December 31, 20X1
Depreciation Expense 900
Accumulated Depreciation 900
Record 20X1 depreciation expense on equipment sold.
Peerless also records the sale of the equipment

at the end of 20X1 and recognizes the $700
($7,000 – $6,300) gain on the sale:
December 31, 20X1

Cash 7,000
Accumulated Depreciation 2,700
Equipment 9,000
Gain on Sale of Equipment 700
Record sale of equipment.
In addition, Peerless records the normal fully adjusted
equity-method entries to recognize its share of Special
Foods’ income and dividends for 20X1.
Assume Special Foods has income of $50,000 and

declares dividends of $30,000:
December 31, 20X1

Record equity-method income: $50,000 × 0.80.
December 31, 20X1

Cash 24,000
Record dividends from Special Foods: $30,000 × 0.80.
To ensure that the income for 20X1 is correct, under

the fully adjusted equity method, Peerless also defers
100 percent of the gain on the downstream
intercompany sale of equipment as follows:
December 31, 20X1

Income from Special Foods 700
Investment in Special Foods 700
Defer unrealized gain on asset sale to Special Foods.
 Three problems arise from such downstream sales:

 Peerless recognizes the gain on the intercompany sale.
 Special Foods places the equipment on the books at
what it paid instead of Peerless’ historical cost.
 There is additional depreciation that Special Foods will
recognize due to the stepped-up basis it received from
purchasing the equipment.
Example 3: End of Year Transfer (1 of 4)
Assume Padre Corp. purchased a machine on 1/1/20X1 for
$100,000 and estimated that the machine would have a useful
life of 10 years with no salvage value. After two years, on
12/31/20X2, Padre Corp. sold the machine to its 100 percent–
owned subsidiary, Sonny Co., for $90,000. Sonny Co. estimated
that the asset had a remaining useful life of five years.
What is the amount of the gain or loss recorded by Padre at
the time of the fixed asset transfer?
Accumulated
Machine Depreciation
Sale:
100,000 20,000
Proceeds $90,000
– Book Value 80,000
Book Value = 80,000 Gain $ 10,000
What accounts and balances actually exist after the fixed
asset transfer?
Accumulated
Machine Depreciation Gain on Sale
90,000 “Actual” 0 10,000
12/31/20X2, Padre Corp. sold the machine to its 100percent–
What balances would have existed if the transfer had not
taken place?
Accumulated
90,000 “Actual” 0 10,000
100,000 “As if” 20,000 0
The worksheet entry on 12/31/X2 to eliminate the asset

transfer is simply the “adjustment” to change from
“actual” to “as if” the asset hadn’t been transferred.
Gain on Sale 10,000

Machine 10,000
Accumulated
90,000 “Actual” 0 10,000

10,000 20,000 10,000
100,000 “As if” 20,000 0
Example 4: Beginning of Year Transfer
(1 of 5)
How much depreciation expense will Sonny record in 20X3?
Depreciation Expense = (C – SV) / # years
= (90,000 – 0) / 5 years = $18,000
How much depreciation expense would Padre have recorded in 20X3
if it had retained the machine and simply changed the estimated life
to five years?
Depreciation Expense = (BV – SV) / # years left
= (80,000 – 0) / 5 years = $16,000
(2 of 5)
Sonny’s 20X3 expense can be separated into two parts:

 The portion associated with the original book value from Padre’s books
 The portion associated with the extra amount paid above Padre’s book
value (the gain)
Gain = 10,000  5 = 2,000 Extra Depreciation

Book Value = 80,000  5 = 16,000 Padre Depreciation
18,000 Total Sonny Depreciation
(3 of 5)
Depreciation Accumulated
Expense Depreciation
18,000 “Actual” 18,000
2,000 2,000
16,000 “As if” 16,000

Depreciation Expense 2,000
(4 of 5)
What balances would have existed if the transfer hadn’t taken place?
Accumulated
90,000 “Actual” 18,000 10,000
100,000 “As if” 36,000 0
(5 of 5)
There are two worksheet entries on 12/31/X3 to compare
“actual” to “as if” to make it appear like the asset hadn’t been
transferred. What is the second elimination entry?
Gain on Sale 10,000
Equipment 10,000
Accumulated
90,000 “Actual” 18,000 10,000
10,000 2,000 20,000 10,000
100,000 “As if” 36,000 0
On 7/1/X8, Pale, Inc. reported a $30,000

gain on equipment sold to Sunny, Inc. (100
percent owned), which extended the then
remaining life of 3 years to 5 years. The
adjustment to depreciation expense in
consolidation at 12/31/X8 is
a. $3,000.
b. $5,000.
c. $6,000.
d. $10,000.
e. None of the above.
(1 of 2)
Book Value = ? 5= ? Parent Depreciation
? Total Depreciation
Don’t forget this is a partial year!

$6,000 × 6/12 = $3,000
(2 of 2)
On 7/1/X8, Pale, Inc. reported a $30,000

gain on equipment sold to Sunny, Inc. (100
percent owned), which extended the then
remaining life of 3 years to 5 years. The
adjustment to depreciation expense in
consolidation at 12/31/X8 is
a. $3,000. ($30,000 / 5) × ½ year
b. $5,000.
c. $6,000.
d. $10,000.
e. None of the above.
On 5/1/X8, Pastor, Inc. had a $30,000 gain
on equipment sold to Sermon, Inc. (100
percent owned) for $150,000. Sermon
extended the then remaining life of 2 years
(original life was 10 years) to 4 years. What
is the consolidated accumulated
depreciation at 12/31/X8?
a. $500,000.
b. $505,000. This is a difficult question!
Solve it in several steps.
c. $510,000.
d. $520,000.
e. $540,000.
(1 of 2)
Equipment Acc. Depreciation
Proceeds: 150,000 600,000 480,000 = 60,000 x 8 years
-BV 120,000 20,000
Gain 30,000 BV = 120,000 500,000 This is the MC answer
8 years 2 yrs
10 year origina life
Parent original depreciation = 120,000 / 2 yrs left = 60,000
Parent NEW depreciation = 120,000 / 4 yrs left = 30,000
Partial year Depr.

Gain = 30,000 ÷4= 7,500 Extra Depr. x 2/3 = 5,000
BV = 120,000 ÷4= 30,000 Parent Depr. x 2/3 = 20,000
37,500 Total Sub. Depr. 25,000
(2 of 2)
On 5/1/X8, Pastor, Inc. had a $30,000 gain
on equipment sold to Sermon, Inc. (100
percent owned) for $150,000. Sermon
extended the then remaining life of 2
years(original life was 10 years) to 4 years.
What is the consolidated accumulated
depreciation at 12/31/X8?
a. $500,000. ($480,000 + [$120,000/4 × 2/3 yr.])
b. $505,000.
c. $510,000.
d. $520,000.
e. $540,000.
Example 5: Partial Ownership Depreciable
Asset Transfer at the End of the Year (1 of 2)
Pericles Corporation sells machinery to its 80 percent–owned
subsidiary, Sophocles Corporation, on 12/31/20X3. The
machinery has a book value of $60,000 on this date (cost
$120,000 and accumulated depreciation $60,000), and it is
sold to Sophocles for $90,000. Thus, this transaction produces
an unrealized gain of $30,000. Assume that Pericles adjusts its
equity-method accounts accordingly.
Note: Transfer is on last day of the year.
Required: 80%
NCI P
1. What journal entry would Pericles make on its 20%
books to adjust for the unrealized gain from this
transaction?
2. What worksheet entry would Pericles make to
consolidate on this date?
S
Asset Transfer at the End of the Year (2 of 2)
Accumulated
Equipment Depreciation
120,000 60,000
Sale:
Proceeds $90,000
Book Value = 60,000
Unrealized Gain $ 30,000
Income from
Investment in Sub Sub
30,000 Defer Gain 30,000
Requirement 1: Equity Method
Income from Sub 30,000

Investment in Sub 30,000
Asset Transfer at the End of 20X3
Accumulated
Equipment Depreciation Gain on Sale
Sub 90,000 “Actual” 0 30,000
30,000 60,000 30,000
Parent 120,000 “As if” 60,000 0
Requirement 2: Worksheet Entry

Gain on Sale 30,000
Equipment 30,000
Example 6: Depreciable Asset Transfer at
Beginning of Year (1 of 3)
Given all other information from the previous example,
assume that the transfer takes place on 1/1/20X4. Also,
assume that as of the date of transfer, the machinery has a
five-year remaining useful life (with no residual value) and
that Sophocles uses straight-line depreciation. In addition to
the journal entries to record the transfer of the asset,
Sophocles also records depreciation expense of $18,000 for
20X4 ($90,000 / 5 years).
Note: Transfer is on first day of the year.
Required:
1. What journal entry(ies) would Pericles make on its books
to adjust for the unrealized gain from this transaction?
2. What worksheet entry(ies) would Pericles make to
consolidate on this date?
Book Value = 60,000  5 = 12,000 Parent Depreciation
18,000 Total Depreciation
Requirement 1:
Of the $18,000 of depreciation recorded, $12,000 is based
on the BV at the time of transfer and $6,000 is based on
the unrealized gain component. We can think of the
$6,000 as the cancellation of 1/5 of the unrealized gain.

30,000 Defer Gain 30,000
6,000 Extra Depreciation 6,000


Beginning of Year (20X4)
Accumulated
Sub 90,000 “Actual” 18,000 30,000
30,000 6,000 60,000 30,000
Parent 120,000 “As if” 72,000 0
Requirement 2: Worksheet Entries

Gain on Sale 30,000
Equipment 30,000

20X4
Adjustments
Consol-
Income Statement
Gain on Sale 30,000 30,000 0
Depreciation Expense 18,000 6,000 12,000
Balance Sheet
Equipment 90,000 30,000 120,000
Accumulated 18,000 6,000 60,000 72,000
Depreciation
Example 6: Subsequent Years (1 of 3)
Given all other information from the previous examples,
consider what happens in the last five years of the asset’s
useful life. Think about both the equity-method entry
Pericles would have to make each year and what
elimination entry would be made each year.

Required:
1. What journal entry would Pericles make on its books to
adjust for the unrealized gain from this transaction on
12/31/X5?
2. What worksheet entry(ies) would Pericles make to
consolidate on this date on 12/31/X5?
Requirement 1:
Pericles will continue to extinguish $6,000 (1/5) of
the unrealized gain each year to its equity accounts.
Equity-Method Entry for all Subsequent Years:

Example 6: Subsequent Years (20X5–20X8)
Investment How much of the deferral is left at

in Sophocles the beginning of each year?
Low 24,000 20X5 Investment in Sub 6,000
6,000 Income from Sub 6,000
0
Example 6: Subsequent Years—20X5
Accumulated Investment
Equipment Depreciation in Sophocles
Sub 90,000 “Actual” 36,000 Low 24,000
30,000 6,000 54,000 24,000
Regular
Parent 120,000 “As if” 84,000
Balance
Requirement 2: Worksheet Entries

Investment in Sophocles 24,000
Equipment 30,000

20X5
Adjustments
Consol-
Income Statement
Balance Sheet
Equipment 90,000 30,000 120,000
Accumulated 36,000 6,000 54,000 84,000
Depreciation
Investment in Sub Low 24,000 Basic 0

24,000
Accumulated
20X6 Worksheet Entries: Equipment Depreciation
Equipment 30,000 Sub 90,000 “Actual” 54,000
Accumulated Depreciation 48,000 30,000 6,000 48,000
Accumulated Depreciation 6,000 Parent 120,000 “As if” 96,000

Accumulated
20X7 Worksheet Entries: Equipment Depreciation
Accumulated Depreciation 42,000 30,000 6,000 42,000
Depreciation Expense 6,000 Parent 120,000 “As if” 108,000
20X8 Worksheet Entries: Accumulated

Equipment Depreciation
30,000 6,000 36,000
Depreciation Expense 6,000 Parent 120,000 “As if” 120,000
20X6
Adjustments
Consol-
Income Statement
Balance Sheet
Equipment 90,000 30,000 120,000
Accumulated 54,000 6,000 48,000 96,000
Depreciation

18,000
20X7
Adjustments
Consol-
Income Statement
Balance Sheet
Equipment 90,000 30,000 120,000
Accumulated 72,000 6,000 42,000 108,000
Depreciation

12,000
20X8
Adjustments
Consol-
Income Statement
Balance Sheet
Equipment 90,000 30,000 120,000
Accumulated 90,000 6,000 36,000 120,000
Depreciation

6,000
Prepare equity-method journal

entries and consolidation
entries for the consolidation of a
subsidiary following an
upstream depreciable asset
transfer.
Upstream Sale
Special Foods sells equipment to Peerless for $7,000 on

December 31, 20X1, and reports total income for 20X1 of
$50,700, including the $700 gain on the sale of the
equipment. Special Foods originally purchased the
equipment for $9,000 three years before the
intercompany sale.
The book value of the equipment at the date of sale is as
follows:
Original cost to Special Foods $9,000

Accumulated depreciation on December 31, 20X1:
Annual depreciation ($9,000 ÷ 10 years) 900
Number of years ×3
(2,700)
Book value on December 31, 20X1 $6,300
Upstream Sale Separate-Company
Special Foods records depreciation on the equipment for
the year and the sale of the equipment to Peerless on
December 31, 20X1, with the following entries:
December 31, 20X1

Depreciation Expense 900
Accumulated Depreciation 900
Record 20X1 depreciation expense on equipment sold.
December 31, 20X1

Cash 7,000
Equipment 9,000
Gain on Sale of Equipment 700
Record sale of equipment.
Peerless records the purchase of the equipment
from Special Foods with the following entry:
December 31, 20X1

Equipment 7,000
Cash 7,000
Record purchase of equipment.
In addition, Peerless records the following equity-

method entries on December 31, 20X1, to recognize
its share of Special Foods’ reported income and
dividends:
December 31, 20X1

Record Peerless’s 80% share of Special Foods’ 20X1 income: $50,700 × 0.80.
December 31, 20X1

Cash 24,000
Record Peerless’s 80% share of Special Foods’ 20X1 dividend: $30,000 × 0.80.
Finally, under the fully adjusted equity method, Peerless

records its share of the gain deferral from the purchase
of the equipment from Special Foods:
December 31, 20X1

Income from Special Foods 560
Investment in Special Foods 560
Defer 80% of the unrealized gain on equipment purchase from
Special Foods: $700 × 0.80.
Example 7: Upstream with Partial
Ownership Depreciable Asset Transfer
On 1/1/X6, Snoopy (an 85 percent–owned subsidiary of
Peanut) sold equipment costing $150,000 to Peanut for
$90,000. At the time of the sale, the equipment had
accumulated depreciation of $110,000. Peanut continued
depreciating the equipment using the straight-line method
and assigned a remaining useful life of five years.
Required:
1. What journal entry would Peanut make on its
NCI
85%
P
books each year to adjust for the unrealized 15%
gain from this transaction?
2. What worksheet entry would Peanut make each
year to consolidate on this date? S
Example 7: Computations (1 of 2)
Equipment Accumulated Depreciation

150,000 110,000
Book Value = 40,000
Sale:
Proceeds $90,000
Example 7: Computations (2 of 2)
Peanut
NCI
Sale:
15% 85%
Proceeds $90,000
Snoopy

Book Value = 40,000  5 = 8,000 Sub Depreciation
18,000 Total Depreciation
Example 7 Solution: Peanut Company
Investment in Snoopy Income from Snoopy
Beg. Bal. 42,500 Defer Gain 42,500

85%
8,500 Extra Depr. 8,500
Low by 34,000
Income from Snoopy 42,500

Year 1
Investment in Snoopy 42,500
Investment in Snoopy 8,500

Income from Snoopy 8,500
Example 7 Solution: Peanut Company
Investment
in Snoopy
Low 34,000 Year 2 Investment in Snoopy 8,500
8,500 Income from Snoopy 8,500
Example 7: Worksheet Entries (1 of 5)
Year 1 Gain on Sale 50,000
Equipment 60,000

Accumulated
Peanut 90,000 “Actual” 18,000 50,000
60,000 10,000 110,000 50,000
Snoopy 150,000 “As if” 118,000 0
Year 2 Investment in Snoopy 34,000
NCI in NA of Snoopy 6,000
Equipment 60,000

Equipment Depreciation in Snoopy
Peanut 90,000 “Actual” 36,000 Low 34,000
60,000 10,000 100,000 34,000
Regular
Snoopy 150,000 “As if” 126,000
Balance
Equipment 60,000

60,000 10,000 90,000 25,500
Regular
Snoopy 150,000 “As if” 134,000
Balance
Equipment 60,000

60,000 10,000 80,000 17,000
Regular
Snoopy 150,000 “As if” 142,000
Balance
Equipment 60,000

60,000 10,000 70,000 8,500
Regular
Snoopy 150,000 “As if” 150,000
Balance
Year 1
Adjustments
Consol-
Income Statement
Gain on Sale 50,000 50,000 0
Balance Sheet
Equipment 90,000 60,000 150,000
Accumulated 18,000 10,000 110,000 118,000
Depreciation
Year 2
Adjustments
Consol-
Income Statement
Balance Sheet
Equipment 90,000 60,000 150,000
Accumulated 36,000 10,000 100,000 126,000
Depreciation
Investment in Snoopy Low 34,000 Basic 0

34,000
NCI in NA of Snoopy 6,000 XXX
Year 3
Adjustments
Consol-
Income Statement
Balance Sheet
Equipment 90,000 60,000 150,000
Accumulated 54,000 10,000 90,000 134,000
Depreciation

25,500
Year 4
Adjustments
Consol-
Income Statement
Balance Sheet
Equipment 90,000 60,000 150,000
Accumulated 72,000 10,000 80,000 142,000
Depreciation

17,000
Year 5
Adjustments
Consol-
Income Statement
Balance Sheet
Equipment 90,000 60,000 150,000
Accumulated 90,000 10,000 70,000 150,000
Depreciation

8,500
Intercompany Transfers of Amortizable Assets
 Accounting for intangible assets usually differs

from accounting for tangible assets in that
amortizable intangibles normally are reported at
the remaining unamortized balance without the
use of a contra account.
 Other than netting the accumulated amortization
on an intangible asset against the asset cost, the
intercompany sale of intangibles is treated the
same in consolidation as the intercompany sale
of tangible assets.
Conclusion
The End

Intercompany Transfers of Services and Noncurrent Assets

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Intercompany Transfers of Services and Noncurrent Assets

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Chapter 7

Understand and explain

 All intercompany transactions must be

 From a consolidated viewpoint,

 Undo the transfer.

 When one company purchases services from a

 The sale of an asset wholly within the consolidated entity

The goal in preparing eliminating entries

The goal in preparing eliminating entries

Prepare simple equity-

 When intercompany transfers of noncurrent

Company A purchases land for $10,000 and sells

 The asset continues to be valued at the $10,000

Peerless Products Corporation acquires land for

Peerless sells the land to its subsidiary, Special

 The intercompany transfer leads to a $15,000 gain on

 In the consolidation process, the gain should be

Gain on Sale of Land 15,000

$40 Parker $100 Stubben $120

“Fake” Gain = $60 Gain = $20

Total Gain = $80

 Compare “Actual” with “As if ”

 The difference between the two gives

On 3/31/X5, Parker Inc. sold land costing $40,000 to its

Gain on the Sale of Land 60,000

Consolidation Entry at 12/31/X5

What happens to the gain?

RE +60 Land +60

Consolidation Entry at 12/31/X6 (and all years until land is sold)

• Thus, the gain in the consolidated financial statements is $80,000!

 After calculating the unrealized gain, simply make an

Investment in Sub Income from Sub

On 3/31/X5, Parker Inc. sold land costing $40,000 to its

$40 Parker $100 Stubben $120

“Fake” Gain = $60 Gain = $20

Total Gain = $80

 Compare “Actual” with “As if ”

 The difference between the two gives

On 3/31/X5, Parker Inc. sold land costing $40,000 to its

Gain on the Sale of Land 60,000

Investment in Sub Income from Sub

This defers the

Investment In Sub Land

Consolidation Entry at 12/31/X6 (and all years until land is sold)

Investment In Sub Gain on Sale

The major difference between the modified

The major difference between the modified

 In downstream transactions, the sale (and

 Peerless products purchases 80 percent of the

Peerless records its share of Special Foods’

Investment in Special Foods 40,000

An equity-method entry must be made to reduce

Income from Special Foods 15,000

Income from Special Foods 15,000

This entry accomplishes two important objectives:

 Stubben Corporation is a 90 percent–owned subsidiary of

20X5 Equity-Method Entries

20X7 Equity-Method Entry (after Stubben resold the land)

Parker’s income includes a $10,000 unrealized gain on

Gain on the Sale of Land 10,000

Investment In Sub Land

Consolidation Entry at 12/31/X6 (and all years until land is sold)

Investment In Sub Gain on Sale